Fiat Currency: A Look Into the History of Paper Money

Modern Economy and History

In the midst of great financial turmoil, rising unemployment and soaring consumer prices, the markets are increasingly worried about the future state of the economy and are slowly losing confidence in what is left of the value of the dollar. However, a look into the history books shows how similar events have occurred repeatedly in the past and demonstrates how nations and empires have always employed the same loosening monetary policies over and over again in order to fund endless wars and large scale projects. Here are a few of the most notable historical examples of how a continuous devaluation of the currency eventually leads the economy to a hyperinflationary blowout and ultimately to the collapse of the government in power.

Ancient Greece

During the mid 7th century B.C., the kingdom of Lydia, located in western Asia Minor, was the first to introduce a currency based on gold. The coins consisted of electrum, an amalgam of gold and silver and were minted of equal weight thus making trading a lot easier. Later on, Athens introduced the coins, leading to a period of great prosperity for the city-state. Athens had not only the first democracy but became a large commercial and trading center. The richness that the city acquired thanks to the use of gold and silver coins was then used to finance large building projects such as the Parthenon, outshining all other neighboring cities.

Still, it didn't take long before the many wars that Athens was involved in depleted the city's wealth. However, the Athenians found a clever way to keep fighting the wars. They realized that by debasing their currency, they could increase the amount of coins in circulation. Rather than minting the coins purely out of gold and silver, the Athenians mixed it with copper while still assigning the same value to the new coins. During the successive years, the city-state kept on debasing the currency by reducing the amount of gold and silver in the coins. This new form of monetary policy worked for a very short period before excessive deficit spending brought the economy to its knees. Athens, a once powerful and prosperous city, would soon lose its prestige and be left defenseless against the might of the rising Roman Empire.

Fall of the Roman Empire

For most, the fall of the Roman Empire was purely caused by the successive waves of attacks led by barbarian hoards coming from the North East, breaking up what was once the most powerful empire that had ever existed. Little do they know that the economy played a key role in this. In order to fund the myriad of wars that Rome was fighting to expand its territories, they kept on devaluing the currency through various means such as mixing coins with copper and minting the same coins at a higher face value to the point that the denari became nothing more than tin-plated metal.

In 300 A.D., Diocletian issued the Edict of Prices imposing a fixed price to all goods as mandated by the government on top of freezing all wages. However, this had the opposite effect desired by the Emperor as workers could no longer sell their goods and had to close down. In a desperate measure to save the economy, Diocletian hired tens of thousands of citizens into the army while simultaneously funding large construction projects in the hope of lifting the economy back. As the money was rapidly vanishing from the coffers, in order to fund its huge welfare system, the government increased the money supply by further debasing the existing coins.

This led to the first recorded hyperinflation in history. A pound of gold went from 50,000 denari in 300 A.D. to over 2 billion denari a few decades later. The huge deficit spending that the Roman Empire had carelessly embarked on led to a systemic collapse of the whole economy and laid the foundations to what was going to become an obscure period in Western history, the Dark Ages.

Tulip Mania: End of The Dutch Golden Age

The Tulip Bulb scandal of 1636 is definitely the most curious case of inflationary collapse.The tulip bulb was first imported into Holland from Turkey in the late 16th century and within a short period of time became a popular item for businessmen and aristocrats alike. The rapidly escalating prices of the flowers incited the gambling instincts of many citizens. A new wave of speculators took over the tulip markets where many where buying and selling futures without holding possession of the goods.

It soon turned into a mania to the extent where, at its very peak, a single tulip would cost up to 6,000 florins, equivalent to 40 times the average Dutch annual income. The smart money understood how crazy this whole game was becoming and started pulling out by investing their profits in gold and silver. Surely enough, things got wilder and wilder until suddenly the bubble burst and the market crashed. In a matter of weeks, tulip prices collapsed and were soon sold at similar prices than any other flower. Thousands were ruined by the sudden drop and the losses were so big that the entire credit system suffered. The end of the Dutch Golden Age had begun.

Weimar Republic

The financial collapse of Germany during the Weimar Republic is one of the most extreme types of hypeinflation witnessed in history. We have all seen images of Germans carrying trolleys loaded with currency and Marks being used as heating mediums. So what actually happened in the run up towards hyperinflation?

It all started during WW1 when Germany had gone into debt due to the large deficit spending to fund the war which it lost. Unlike France, which imposed an income tax on its citizens, the Kaiser decided to fund the war purely by borrowing money, resulting in the Mark loosing over half its value against the U.S. Dollar throughout the conflict. Furthermore, the Parliament froze the convertibility of its currency into gold. At the end of WW1, the Treaty of Versailles hit the Deutschmark even more as Germany had to pay reparation costs with hard assets which led the country into further debt.

However, the real cause behind the hyperinflation is what was known as the London Ultimatum. In May 1921, Great Britain demanded reparation costs of 2 billion gold-marks on top of 26% of the country's total export value. The only option for Germany was to run its printing press even more. While the currency was stable at 60 Marks per U.S. Dollar during the first half of 1921, a year later it was devalued to 320 per U.S. Dollar and by December of that year it had gone all the way up to 6000 Marks. In 2013, the figures went in the millions, billions and then trillions. By the end of 1923, there were some 1.2 Sextillion paper Marks in circulation!

Where are We Headed?

Fast forward 90 years. The U.S. Dollar plays the leading role in the global economy being the world's reserve currency. The U.S. government has a debt of over $16 trillion and counting, with unfunded liabilities estimated at more than $100 trillion. Deficit spending keeps on increasing and the government has no intention to cut the defense budget as it needs to fund its imperialistic campaigns around the globe. Since the Federal Reserve was founded in December 1913, the U.S. Dollar has lost more than 97% of its purchasing power while gold prices keep on scoring new all time highs.

After President Nixon took the United States off the Gold Standard in 1971, all the world's major currency have since been backed by nothing but thin air. Since the 2008 credit crunch, the major central banks have been engaged in a series of quantitative easing and bond buying programs aimed at bailing out the banks and bringing back consumer confidence to its previous highs. However, the measures taken so far have given poor results and as the markets get more of the same medicine, the reaction becomes smaller after every round.

Deflation, a contraction of the money supply, is Bernanke's greatest nightmare and the Federal Reserve Chairman, along with Eurozone Central Bank President Mario Draghi, will stop at nothing to avoid such a scenario playing out by keeping the printing presses going. A brief lesson of basic economic history teaches us that a loosening monetary policy whereby the money keeps on being devalued to fund endless wars, will ultimately provoke a hyperinflationary blowout as the markets lose confidence in the currency. At this point in time, your best bet is investing in hard assets such as gold, silver and agricultural commodities.

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